Case 024Debt capacity and loan structuringCore
Sponsor-owned Palveda Auto Parts has a Rs 450 crore unitranche at 5.0x EBITDA of Rs 90 crore. It wants to buy a rival with EBITDA of Rs 20 crore at 8x, funded by Rs 160 crore of extra debt. Compute pro forma leverage with and without Rs 5 crore of synergies, and set your terms for the add-on.
1The situation
Your fund is the sole lender on a Rs 450 crore unitranche loan to Palveda Auto Parts, owned by a private equity sponsor. EBITDA is Rs 90 crore, so leverage is 5.0x, and the loan costs 11%. Your credit committee's limit for this borrower is 5.0x.
The sponsor wants to buy a smaller rival with EBITDA of Rs 20 crore for 8.0x, Rs 160 crore, and asks you for a Rs 160 crore add-on to the loan. The sponsor's model shows Rs 5 crore of cost synergies within a year and presents leverage including them.
2Your task
Work out pro forma leverage with and without the synergies, and set the terms on which you would provide the add-on.
Quick check
Why does leverage rise even though Palveda is buying more EBITDA?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
Pro forma leverage is 5.55x without synergies and 5.30x with them, both above a 5.0x limit. I would lend a Rs 100 crore add-on, which keeps leverage at 5.0x on EBITDA of Rs 110 crore, ask the sponsor for Rs 60 crore of equity, and offer a further Rs 25 crore only once the synergies show up in trailing EBITDA.
Step 1What does the acquisition do to leverage?
Buying earnings at a higher multiple than your own leverage, with all debt, always raises leverage. A shop owing five times its yearly profit that borrows eight times the profit of the shop next door ends up owing more relative to what it earns. Debt goes to Rs 610 crore and EBITDA to Rs 110 crore, so pro formaFigures restated as if a transaction had already happened, so the combined business can be judged before it exists. leverage is 5.55x, above the 5.0x limit.
Step 2Should the synergies count?
Not at first. Synergies are a forecast by the party that wants the money. Counting Rs 5 crore of synergies takes leverage to 5.30x, still over the limit, and relies on savings that have not happened yet. Lenders look at leverage without them first, and treat any add-backAn amount added to reported EBITDA for expected savings or one-off costs, which makes leverage look lower than on reported figures. for synergies as something to earn, not something to lend against on day one.
Step 3How much can you lend?
Size to the limit on reported numbers. 5.0x of combined EBITDA of Rs 110 crore is Rs 550 crore of debt, so the add-on can be Rs 100 crore, and the sponsor funds the remaining Rs 60 crore of the price with equity. Interest cover then stays at about 1.82x, the same as today, instead of falling to 1.64x with the full Rs 160 crore.
| Rs crore | Today | Full add-on of 160 | Proposed add-on of 100 |
|---|---|---|---|
| Debt | 450 | 610 | 550 |
| EBITDA | 90 | 110 | 110 |
| Leverage | 5.00x | 5.55x | 5.00x |
| Interest at 11% | 49.5 | 67.1 | 60.5 |
| Interest cover | 1.82x | 1.64x | 1.82x |
| Sponsor equity needed | 0 | 60 |
Step 4What terms would you set?
Make the sponsor share the risk and let the synergies earn the rest. Lend Rs 100 crore on the same terms as the existing loan, require Rs 60 crore of sponsor equity, and add an accordion of Rs 25 crore that can be drawn only when trailing EBITDA reaches Rs 115 crore. Cap synergy add-backs at 10% of EBITDA and only for actions taken within twelve months, take an upfront fee for the work, and diligence the rival's Rs 20 crore as carefully as Palveda's own. The view: supportive of the deal, not of the leverage.
Where candidates lose it
The usual miss is accepting leverage with synergies as the headline. The sponsor's number is the most optimistic one; the lender's job is to start from reported EBITDA and let the synergies be proved.
The second is saying no to the deal. A good private credit answer finds the structure that works: less debt, more equity, and more later if the plan delivers.
What the interviewer asks next
- The sponsor refuses to add equity. What else could you ask for instead?
- What if the rival's EBITDA includes Rs 4 crore of one-off gains?
- How would you price the add-on if the market for similar loans has tightened by 50 basis points?
Company names and figures are illustrative.